Don't Bet on Aramark...At Least Not Yet

Food services and uniform company Aramark recently debuted on the NYSE, but will its debt load prevent it from attaining its true growth potential?

There's little that can rival the arrival of a new stock on Wall Street. A new issue represents potential, possibilities, and profits. It's easy to get caught up in the allure of a new stock, but does that necessarily mean that a recent IPO is good for your portfolio? In the case of Aramark(NYSE:ARMK), which in December 2013 made its third debut in the stock market after transitioning to the private markets a couple of times, it's not black and white.

Aramark provides food services and uniforms to various segments of the economy across education, health care, business and industry, and sports, leisure, and corrections. It's a growing business, and annualized revenue from clients retained in 2012 was $1 billion-plus. Some recent client-adds include "Airbus, the Ohio and Michigan departments of corrections, American University, the Minnesota Vikings, the Chicago Bears, and the Tampa Bay Buccaneers," according to an SEC filing.

On the surface, everything looks OK. Total sales were $13.9 billion in fiscal 2013 and $13.5 billion in 2012, representing increases of 6% and 3%, respectively, versus fiscal 2011. Aramark sees the most growth potential in its core business in North America, but also services nearly two dozen countries across Europe, Asia, and South America.

Third time's a charm?Aramark has a pattern of entering and exiting the public markets, having IPO'd twice before--first back in 1960 and then again in 2001. Meanwhile, the size of its debt load has exploded in the process.

As of Sept. 27, 2013, Aramark has $5.8 billion in total debt. That's below the $7.3 billion that the company inherited by 2008 after its private equity consortium-led takeover in 2007, but still exceeds the $2 billion in debt the company carried on its balance sheet in 2005, according to PE Hub.

Aramark has been whittling away at its debt and extending a portion of maturities out to 2016; there is another portion of debt not coming due until 2019, all of which speaks well of Aramark's liquidity, or access to cash, as it grows. Nonetheless, with the overhang of having to service that debt, shareholder value can get pushed lower on the list of priorities, even for a newly public company.

Ratings agency Moody's assigned a B1 corporate family grade to Aramark's debt, which according to the rating agency itself is a strong grade in light of the size of the company's debt load, as reported in PE Hub. The reason for the solid rating is Aramark's cash flow, which Moody's said is sufficient to cover the company's debt load. In fiscal 2012, Aramark had $337 million in free cash flow with an estimated $250 million in free cash flow in fiscal 2013.

Key relationshipsIn its food and support services business, Aramark is heavily dependent on a single distributor -- Sysco. If a business is going to be dependent on a single distributor, Sysco, with $44.4 billion in fiscal 2013 revenue (up 4.8% year over year), isn't a bad choice. But by Aramark's own admission:

"If our relationship with, or the business of, SYSCO were to be disrupted we would have to arrange alternative distributors and our operations and cost structure could be adversely affected in the short term." -- Aramark S-4 Filing

According to Aramark's SEC filing, "In fiscal 2013, SYSCO distributed approximately 60% of our food and non-food products in the United States and Canada." There's always an element of risk when a company is heavily dependent on a single distributor for a portion of its business, and food and support services in North America generated nearly 70%, or $9.6 billion, of Aramark's total sales in fiscal 2013.

On the uniform front, Aramark competes with UniFirst(NYSE:UNF), a company that reported $1.3 billion in revenue for fiscal 2013, which was a near 8% jump versus fiscal 2012 levels. UniFirst sports a solid quarterly debt-to-equity ratio of 0.1, which as a uniform play makes the company an attractive alternative to the debt-laden Aramark.

ConclusionThere's lots to like about Aramark. It's led by former PepsiCo executive Eric Foss, has nearly doubled it sales generated from emerging markets since 2007, and has growth plans for its core North American business. It's a growing company, but one whose potential is tainted until it can further strengthen its balance sheet, e.g., lower its debt load.